Is Spotify Technology (NYSE:SPOT) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Spotify Technology S.A. (NYSE:SPOT) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Spotify Technology

How Much Debt Does Spotify Technology Carry?

The image below, which you can click on for greater detail, shows that at September 2021 Spotify Technology had debt of €1.18b, up from none in one year. However, it does have €3.17b in cash offsetting this, leading to net cash of €2.00b.

How Strong Is Spotify Technology's Balance Sheet?

We can see from the most recent balance sheet that Spotify Technology had liabilities of €3.08b falling due within a year, and liabilities of €1.80b due beyond that. Offsetting this, it had €3.17b in cash and €576.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.13b.

Given Spotify Technology has a humongous market capitalization of €42.6b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Spotify Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Spotify Technology made a loss at the EBIT level, last year, but improved that to positive EBIT of €45m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Spotify Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Spotify Technology may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Spotify Technology actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about Spotify Technology's liabilities, but we can be reassured by the fact it has has net cash of €2.00b. And it impressed us with free cash flow of €245m, being 544% of its EBIT. So we don't have any problem with Spotify Technology's use of debt. While Spotify Technology didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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